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Econintersect: The National Federation of Independent Business (NFIB) Index of Small Business Optimismrose 1.5 points in January, a modest increase, opening the new year with a reading of 94.1. The slight overall uptick in optimism might have been higher, but was blunted by small business owners’ skepticism about the future and continued hesitancy to spend and hire. Weak sales is still the most frequently cited top business problem. However, price-cutting is fading, and inventory-adjustments to match lower consumer spending appear to be reaching a conclusion.

Follow up:

“Manufacturing and exporting are leading the recovery—industries and activities that are not labor intensive—while construction, an industry historically dominated by small firms, remains depressed,” said NFIB chief economist Bill Dunkelberg. “While recent political rhetoric favors small business, it is belied by the actions of policy makers whose new policies and activities almost exclusively support big businesses. While the economy is moving forward, albeit at a snail’s pace, it is not nearly fast enough to dramatically improve the unemployment situation, which continues to languish.”

Employment

After reaching the “0” line in October and November, job creation turned negative in December and deteriorated further in January. The average employment change per firm over the past three months was -0.15 employees. There were fewer increases and more reports of shrinkage in workforces, with 11 percent increasing employment—an average of 2.8 employees per firm, and 15 percent reducing employment—an average of 2.9 employees per firm (seasonally adjusted). In context, the average increase in employment per firm has been negative for 33 of the last 37 months. New firms will add jobs (although the latest data show more “exits” than “starts”), but the existing firms accounted for the bulk of the lost jobs in the recession and will be the firms that will rehire them once economic growth gains pace and becomes more secure.

The frequency of reported capital outlays over the past six months rose 4 points to 51 percent of all firms; while an increase, this is historically low and far less than needed after years of recession and depreciation. Owners remain in “maintenance mode,” apparently unwilling to risk new capital investments or not seeing need for them.

The percent of owners planning capital outlays in the future rose 1 point to 22 percent, but is still historically quite low. Eight percent characterized the current period as a good time to expand facilities (seasonally adjusted), unchanged, but 6 points better than a year ago and the third highest reading since the economy peaked in December 2007. A net 10 percent expect business conditions to improve over the next six months, up one point, but not characteristic of a strongly rebounding economy.

Sales and Inventories

The net percent of all owners (seasonally adjusted) reporting higher nominal sales over the past three months improved by 5 points for a net negative 11 percent, 23 points better than March 2009 (near the recession bottom) but still indicative of weak customer activity. Unadjusted, 21 percent of all owners reported higher sales (last three months compared to prior three months, up 3 points) while 36 percent reported lower sales (unchanged). Although consumer spending appears to have risen at a robust 4 percent rate in the fourth quarter, small businesses did not appear to have benefited much from the spending gains (unless they were auto dealerships). Overall, sales trends do not appear supportive of a widespread recovery in the small business sector.

The net percent of owners expecting higher real sales continued to rise, gaining 5 points to a net 13 percent of all owners (seasonally adjusted), a 16 point gain since September. Not seasonally adjusted, 33 percent expect improvement over the next three months (up 7 points) and 26 percent expect declines (down 10 points), both of which are solid gains.

Small business owners continued to liquidate inventories but at the lowest frequency in 34 months. A net negative 10 percent of all owners reported growth in inventories (seasonally adjusted), down 3 points. January is the 34th consecutive month with a negative double digit reading for reported reductions, and the 44th consecutive month with a negative reading for inventory changes. For all firms, a net 0 percent (up 3 points) reported stocks are too low, historically a very positive level of stock satisfaction. Plans to add to inventories gained 2 points to a net negative 1 percent of all firms (seasonally adjusted), consistent with weak sales trends, but not consistent with the improved outlook for real sales volumes. While the outlook is still tentative, it appears that the inventory reduction cycle is about over.

Inflation

The downward pressure on prices appears to be easing as more firms are raising prices and fewer are cutting them. Eighteen percent of owners (down 2 points) reported raising average selling prices, and 20 percent reported average price reductions (down 4 points). January is the 26th consecutive month in which more owners reported cutting average selling prices than raising them. However, the trend is clearly supportive of higher prices in future months. Plans to raise prices rose 4 points to a net seasonally adjusted 19 percent of owners, the highest reading in 27 months.

Earnings

Reports of positive earnings trends improved in January, registering a net negative 28 percent. While an improvement, there are still far more owners who report that earnings are deteriorating quarter on quarter, and not rising. Part of this is due to price-cutting, which is fading in frequency as the economy continues to grow. Not seasonally adjusted, 15 percent reported profits higher (up 1 point), but 44 percent reported profits falling, a 3 point decline.

Overall, 92 percent of small business owners reported that all their credit needs were met or that they were not interested in borrowing; eight percent reported that not all of their credit needs were satisfied; and, 52 percent said they did not want a loan, a 2 point increase. Only three percent reported financing as their top business problem, down 2 points from December. Twenty-seven percent of the owners reported that weak sales continued to be their top business problem (down 6 points) in the last month, followed by 19 percent citing taxes and 17 percent government regulations and red tape (taxes that consume capital and entrepreneurial time). The historically high percent of owners who cite weak sales means that, for many owners, investments in new equipment or new workers are not likely to “pay back.” This is a major cause of the lack of credit demand observed in financial markets along with the deficiency in housing starts, a million units below “normal.”

This report is based on the responses of 2,144 randomly sampled small businesses in NFIB’s membership, surveyed throughout the month of January.

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